Rent Seeking: Some Conceptual Problems and Implications · 2019. 11. 13. · Rent Seeking: Some Conceptual Problems and Implications E.G. Pasour, Jr. T here is increasing use of the

Rent Seeking: Some ConceptualProblems and Implications

E.G. Pasour, Jr.

T here is increasing use of the concept of rent seeking to describeresource-wasting activities of individuals and groups seeking wealthtransfers.1 A wide range of activities are presumably of this type in-cluding agricultural price supports, occupational licensing, labor unions, im-port and export quotas, and education subsidies. The term rent seeking is usedto describe attempts both to obtain and to maintain wealth transfers. Althoughthe terminology of rent seeking is quite recent, the behavior that it describes"has been with us always" (Buchanan, 1980, p. 3). Moreover, rent-seekingbehavior has become more important as institutional changes have created op-portunities that did not exist when there was general agreement that the stateshould play a more limited role. Mancur Olson (1982) contends that the in-crease in specialized pressure groups is a key factor in the declining economicgrowth rate of nations—adding to the criticism of this widespread phenomenonin which organized groups use the power of the state to further their own eco-nomic ends.

There is an implicit assumption in the literature that rent-seeking behaviorcan be objectively identified and that waste due to rent seeking can, at least inprinciple, be measured (Posner, 1975; Tullock, 1967). The problem of identify-ing rent-seeking activity under real world conditions is shown in this article tobe similar to that of determining monopoly waste and other market inefficien-cies.2 It follows that rent-seeking waste can only be identified by substituting theobserver's own standard of value. Moreover, if an activity is a legitimate func-tion of the state, it is held that the lobbying associated with instituting and main-taining the activity is not necessarily wasteful. Consequently, since the appropriaterole of the state is normative, identifying a particular activity as wasteful mustnecessarily be based on norms that lie outside of economic theory.

This article was presented as a paper at a New York University-Liberty Fund Research seminarin Austrian economics, August 7 -11 , 1983. The author wishes to thank members of the seminarand Terry Anderson, Marc Johnson, Dwight Lee, Jim Leiby, Rolf Mueller, and Ray Palmquist forhelpful comments and suggestions.

124 • The Review of Austrian Economics

The procedure of this article is as follows. Shortcomings of the conven-tional long-run equilibrium approach used in identifying monopoly waste arefirst described. The problem of groups attempting to achieve income transfersthrough the power of the state—nonmarket rent seeking—is then discussed.The lack of an appropriate benchmark in identifying inefficiency and wasteunder real world conditions of uncertainty (which renders information costlyand is a major source of "government failure") is emphasized throughout theanalysis. Despite the fact that rent-seeking theory provides no objective meansof separating beneficial from wasteful government activities, it is argued thatsuch waste exists because of imperfect coordination in political markets. Thereis increasing concern about the effects of activities by individuals and groupson the economic and political order and a growing perception that redistribu-tion is the explanation for many government activities ostensibly justified onthe basis of the "public interest." Implications of the increase in redistributiveactivities are discussed in the last section of the article. Although economiceducation is identified as a necessary precondition in reducing the scope forrent-seeking behavior, it is argued that ethical considerations are inherent inthe use of state power to stifle competition where individuals are assumed tohave the right to engage in mutually beneficial exchange.

Downward-Sloping Demand Curvesand Resource Misallocation

There is a close relationship between rent-seeking theory and conventionalmeasurements of monopoly waste. Monopoly is traditionally defined as a situa-tion where demand is not perfectly elastic (Friedman, 1976, p. 126). In analysesof the resource (or "welfare") cost of monopoly by A.C. Harberger, RichardPosner, Gordon Tullock and others, long-run equilibrium is taken as the pointof reference, and real world markets are compared with the perfectly competitiveequilibrium. If the economy were perfectly competitive, there would be no prof-its or losses. Consequently, in this long-run competitive equilibrium framework,all profits are due to monopoly, are considered to be permanent, and implya welfare loss (Littlechild, 1981).

The alternative to considering monopoly as a market situation where de-mand is not perfectly elastic is to view market competition as a process (Hayek,1948; Kirzner, 1973,1979). In the analysis of firms facing downward-slopingdemand curves, the market process approach stresses the necessity of usinga model that allows above-average rates of return due to entrepreneurship. Whilethere is no role for entrepreneurial activity in competitive equilibrium whereall decisions by market participants are perfectly coordinated, there are oftenprofit opportunities for alert entrepreneurs under real world conditions wheremarkets are seldom (if ever) in equilibrium.

Rent Seeking • 125

Consider the example of an entrepreneur who develops a product beforeother potential producers and, consequently, faces a downward-sloping demandcurve. The seller charges the monopoly price, OP (figure 1). In the conven-tional long-run equilibrium approach, the rectangle (T) is considered to bemonopoly profit and the triangle (W.C.) a deadweight resource cost.3 In thisapproach, all traces of monopoly power represented by less than perfectly elasticdemand involve a "welfare cost" and are branded as socially harmful. However,the relevant alternative to output oq1, for the time being at least, is not OQ2,but rather no output at all. Under these conditions, it is inappropriate to depictthe producer's action as socially harmful and generating a deadweight loss(W.C). Instead, using the same analytical tool, the action of the decision makercan be said to generate a social gain given by his own entrepreneurial profit(T) plus the consumer surplus (C.S.) (Littlechild, 1981, p. 358).

The long-run equilibrium approach overlooks or discounts the impor-tance of entrepreneurial activity to cope with change and the returns necessaryto induce the decision maker to perform that function. In the words ofBuchanan (1980, p. 5): "By seeking always to find new opportunities . . . andto exploit more fully existing opportunities, profit-seeking entrepreneurs generatea dynamic process of continuous resource reallocation that ensures economicgrowth and development." In marked contrast, there is no scope for beneficialprofits in the conventional approach to economic analysis. The extra incomeearned by successful entrepreneurs is taken to be a measure of welfare loss ratherthan the return necessary to evoke beneficial entrepreneurial activity. This

PRICECOST

p

C

0

c.s. \ .

T \

W.C.

11

QUANTITY/UNIT TIME

Figure 1. Monopoly Waste—Conventional Approach


approach fails to recognize that profits and losses are the signals that directeconomic activity in a market economy. In the words of von Mises (1974,p. 119): "Profits are never normal. They appear only where there is a malad-justment. . . . The greater the preceding maladjustments, the greater the profitearned by their removal." For economic decision makers who are risk averters,it may be necessary to have even higher expected returns to remove malad-justments in resource use. Thus it is necessary to consider a long-run viewof the market process in understanding the importance of entrepreneurialreturns.4

The long-run equilibrium framework used in identifying the welfare costof monopoly is inappropriate under real world conditions where returns in-clude short-run disequilibrium profits due to entrepreneurial alertness. The en-trepreneurial profits which may appear to be "rents" from a short-run perspectiveare, in fact, the driving force of the market system.5 Moreover, since theamount of entrepreneurial activity hinges on the expected returns, a social policywhich arbitrarily confiscates the returns due to entrepreneurial alertness willinevitably discourage such alertness in the future (Kirzner, 1973). In summary,by considering all downward-sloping firm demand curves to be socially wasteful,conventional analyses of monopoly fail to take into account the nature androle of profits in the market process.

The long-run equilibrium framework used by Tullock, Posner, and othersin analyzing rent-seeking waste associated with monopoly is also inappropriate.Although rent seeking mainly focuses on transfers obtained through the aegisof the state, the term is also used to describe activities motivated by lure ofprofits when the monopolies are not rooted in government power.6 Specifi-cally, it is held that rent-seeking resource waste in the market situation shownin figure 1 consists not only of the traditional deadweight loss (W.C.), butalso of some or all of the transfer (T) which, it is argued, is dissipated in at-tempts to obtain or maintain monopoly profits. As suggested, however, thedescription of these areas as resource waste ignores the benefits of en-trepreneurial activity. Although the competitive entrepreneurial process (if suc-cessful) generates profits, the cost inherent in the uncertainty and innovationassociated with attempts to obtain such profits should not be regarded as wastesince effective resource use "will continue to require resources devoted to cop-ing with and initiating changes" (Worcester, 1982, p. 86). Thus, entrepreneurialactivity, reflected in downward-sloping demand curves, results in the creationof added value rather than rent-seeking waste. Moreover, except when monop-oly is defined in terms of government restrictions on entry, there is no wayto distinguish downward-sloping demand curves due to entrepreneurial fore-sight from other cases of "monopoly." Consequently, in the case of downward-sloping demand curves, there is no way to distinguish rent-seeking activityfrom the profit seeking of the market process except where competition isrestricted through state power.


Nonmarket Rent Seeking

Rent seeking, as suggested, is mainly used to describe the effects of attemptsby groups to achieve profits through government restrictions on entry(Buchanan, 1980, p. 9).7 So long as the functions of government arerestricted to those of the classical minimal state, there are relatively few op-portunities to obtain income transfers in this way. As the functions of govern-ment have increased, however, there has been a concomitant increase in at-tempts by individuals and groups to create income opportunities throughpolitical activity. Lee (1983, pp. 15-16) describes the increase in rent-seekingactivities in the United States:

For over a century most government activity, as measured by revenue raisedand spent, took place at the state and local level where intergovernmental com-petition imposed restraint. . . . In the environment established by this govern-ment restraint there was little to gain from political enterprise, or transfer ac-tivity, but much to gain from market enterprise, or productive activity. . . .But the existence of political power, even when restrained, establishes poten-tial opportunities for some to benefit at the expense of others that will neverbe completely ignored. . . . There can be no reasonable doubt that there hasbeen a dramatic expansion in the range of activities that have been subjectedto government control over the last century.

Consider, as an example of rent seeking, the case of agricultural price sup-ports where product prices and producer incomes are increased by restrictingoutput through the use of production allotments. Traditionally it has beenassumed that producers initially assigned allotment rights receive windfall gains.Posner (1975, p. 809), assuming that supply is perfectly elastic, however, showsthat, "at the margin, the cost of obtaining a monopoly is exactly equal to theexpected profit." If this is correct, the cartel gains would be completely dissipatedthrough competitive rent-seeking activity. The forgone consumer surplus wouldnot be converted into monopoly profit but would instead be dissipated in theform of real resource expenditures including lobbying and other activities re-quired to obtain (and maintain) the favorable legislation (figure 2).

In figure 2, as cost increases from MC to MC9, the entire value of the ex-pected returns is exhausted through rent-seeking activity. This rent-seeing modelthen is similar to the theory of the firm in the conventional equilibrium ap-proach of neoclassical theory. In market equilibrium, all decisions perfectlymesh, all profit opportunities are exhausted, and since competition is no longeran active force, there is no scope for entrepreneurship. Similarly, there is noscope for rent-seeking activity in the equilibrium depicted in figure 2. Stateddifferently, the equilibrium condition depicted implies the cessation of rent seek-ing since all opportunities to secure income transfers through political meanshave been exhausted and there is no further potential for gain.


PRICE

- MC

MC

QUANTITY/UNIT TIME

0 2

Figure 2. Rent Seeking—Constant Costs and Competitive Conditions

Noncompetitive Rent Seeking

Tullock argues that the rent-seeking incentive remains "even if we can find anequilibrium" (1980b, p. 98). He contends that costs are likely to be increasingrather than constant (as in figure 2) so that "the supply curve slants up andto the right from its very beginning" (ibid). Using an experimental game withsome special assumptions about individual knowledge, Tullock examines theproperties and outcomes of strategy games. In the specific game analyzed, afixed prize is offered and participants are asked to make sealed bids for theprize. It is assumed that "if there is a correct solution for individual strategy,then each player will assume that the other parties can also figure out whatthe correct solution is" (ibid., p. 99). Marginal adjustments in bids are allowedand players are considered to be able to compare marginal costs and marginalreturns. Tullock finds situations in which individual players will make con-tributions larger than the expected prize (overbidding) and cases in which thesum of players' bids is less than the value of the prize (underbidding). Sinceboth underbidding and overbidding are observed, there appears to be no generaltendency toward exact dissipation of the prize. Thus, it is argued, the com-petitive model where the expected return is exactly wasted cannot be takenas the general rent-seeking model (Tollison, 1982, p. 586).

It is not clear, however, that games that assume that individuals can figureout the correct strategy by comparing marginal costs and returns provide anyuseful information about rent-seeking activity under real world conditions of


uncertainty. In rent seeking through the political process, there is uncertaintyboth about the size of the prize (value of the advantage secured through politicalmeans) and the probability of success in achieving it. Under these conditions,one might expect each rent-seeking group to invest in political activity so longas the expected benefits exceed the expected costs. As in the case of marketentrepreneurship, however, there is no reason to think that returns would beexactly dissipated where choices are always shrouded in uncertainty. The deci-sion maker faces similar information problems whether the wealth-seeking ac-tivity is directed toward the market process or the political arena. In either case,neither the alternative outcomes nor the probabilities of their occurrences canbe fully known at the time of choice—raising questions as to the usefulnessof probability theory in analyzing choice.8

Although individual interpretations and expectations will differ where realworld conditions are constantly changing, there are opportunities for individualsand groups to engage in rent seeking through the political process just as thereare opportunities for alert entrepreneurs in markets for goods and services.It is ironic that while profit maximization in both conventional neoclassicaltheory and rent-seeking theory is developed within an equilibrium framework,the emphasis placed on wealth-seeking behavior is quite different. In the con-ventional theory of the firm, the focus is on equilibrium conditions and en-trepreneurship is largely neglected (Kirzner, 1973, 1979; Schultz, 1980). Inthe case of rent seeking, in contrast, the focus is on lobbying and other activityof groups attempting to use the political process for economic gain.

Problems in Identifying Rent-Seeking Waste

Since rent seeking is but one form of economic waste or inefficiency, first con-sider the general problem of identifying inefficiency in economic activity.Economic efficiency studies in conventional welfare economics typically usethe benchmark of perfect competition which assumes price-taking behaviorand perfect markets requiring perfect communication, instantaneousequilibrium, and costless transactions (Hirshleifer, 1980, p. 232). Since no realworld market can match these conditions, all real world markets are ineffi-cient on the basis of this criterion.9 Consider, for example, conventionalmonopoly theory which evaluates the extent of monopoly waste by compar-ing market conditions against the perfectly competitive norm (Armentano,1982). Resource waste (as just shown) will appear to be an important prob-lem on the basis of this criterion even when the extra income earned in anyperiod is due to entrepreneurship. Moreover, market failure in the form of adver-tising, incomplete information, and externalities (as well as monopoly) willinevitably appear to be pervasive when real world markets are compared againstthe competitive norm (Pasour, 1981).


Demsetz (1969) has labeled this procedure of comparing existing "im-perfect" arrangements with an unattainable ideal "the nirvana approach."Although it is clearly inappropriate to use a model that assumes away prob-lems facing the entrepreneur in assessing entrepreneurial efficiency, no one hasdiscovered an appropriate benchmark for evaluating the efficiency of real worldchoices made under conditions of uncertainty and costly information. Effi-ciency inevitably involves valuation; to be meaningful in a choice sense, anyefficiency measurement must be based on the costs and returns confrontingthe decision maker. It is opportunity cost that influences individual choice,however, and the value of the sacrificed alternative to the decision maker can-not be determined by an outside observer. Moreover, the ultimate end of ac-tion is always the satisfaction of desires of the acting individual and "no manis qualified to declare what would make another man happier" (von Mises,1966, p. 19). Since individuals base choices on data that are inherently sub-jective, the economist can identify waste in the actions of other people onlyby imposing his own standard of value (Buchanan, 1979, p. 61; Sowell, 1980,p. 218).10

A similar problem arises in identifying wasteful rent-seeking behavior whereindividuals attempt to achieve wealth transfers through the political process.Little attention has been devoted to the problem of identifying wasteful behaviorin the rent-seeking literature. The examples of Tullock (1967) and Posner(1975), using the competitive norm as a benchmark, suggest that efforts toachieve monoplies, tariffs, and labor unions are rent-seeking waste. Bhagwati(1982), on the other hand, argues that rent-seeking behavior is not necessarilywasteful.11 In the case of lobbying to restore free trade, for example, it is con-tended that rent-seeking activities may be beneficial or harmful depending uponwhether "the resources used up in restoring free trade that is the lobby'seconomic advantage are socially more valuable than the social gains from freetrade" (Bhagwati, 1982, p. 997).

In a book on income transfers, Tullock (1983) suggests that harmfulredistribution can be identified by the motive.12 The effect of government in-tervention, however, is not determined by the motives of those responsible forobtaining and maintaining a particular activity. The effects of minimum wagelegislation, for example, are similar whether or not the motive of the proponentsis self-serving. Moreover, most transfer programs involve a mix of motives; inanalyzing any real life redistributive activity, there is no reliable way to deter-mine the choice influencing motive.

The Bhagwati and Tullock analyses have the same shortcomings as all otherapproaches based on measurements of social costs and gains. The opportun-ity cost of any decision, as suggested above, depends upon the decision maker'santicipation of future conditions. Thus, opportunity cost is inherently subjec-tive and distinct from data that can be objectively measured by the outsideobserver (Buchanan, 1969). The difficulties are magnified when the economist


attempts to make interpersonal comparisons of gains and losses in utility.13

Utility is a subjective concept and gains and losses in utility by different in-dividuals cannot legitimately be measured or weighed against each other(Rothbard, 1982, p. 204).

Consider again the problem of identifying inefficiency on the part of theindividual decision maker. If the economist identifies an activity as wastefuland the decision maker continues the activity, one cannot legitimately con-clude that the activity is wasteful; instead, it might be concluded that the analysthas not measured the choice-influencing opportunity costs and benefits. Simi-larly, if after pointing out the wastes of rent controls, the necessary politicalchanges are not made, what conclusion can one draw.?14 In attempting toidentify institutional inefficiency, the economist faces problems similar to thosein identifying inefficiency on the part of the individual decision maker.15

Once, it is recognized that cost and value are subjective concepts, it becomesclear that "net social benefit is an artificial concept of direct interest only toeconomists" (Littlechild, 1978, p. 92). Consequently, the effects of trade bar-riers arising through rent-seeking activity cannot be determined by comparingthe gain in utility of producers at the expense of consumers. In the words ofRobbins (1981, p. 5):

[W]henever we discuss distributional questions, we make our own estimatesof the happiness afforded or the misery endured by different persons or groupsof persons. But these are our estimates. There is no objective measurementconceivable.

Thus, utilitarian approaches do not present a way of determining which ac-tivities are wasteful. Furthermore, as shown in the following section, whetheror not an activity is considered to be rent seeking hinges on one's view of thelegitimate role of the state.

Rent Seeking and the Role of the State

Consider first the minimal state where law and order are deemed to be theonly appropriate functions of government. In this case, the lobbying and otherresource costs necessary to achieve and maintain the proper level of supportfor these essential activities would not be rent-seeking waste. On the other hand,resources expended by teachers to enact (or preserve) a system of public educa-tion would be wasteful if education were not a proper function of the state.Thus, as in other cases of alleged inefficiency, rent-seeking waste can be iden-tified only by substituting the observer's own standard of value.

Consider again the example of education. It is often argued (at least byeducators) that education is a public good and, consequently, is a proper


function of the state. If education is a proper role of the state, the use of resourcesdevoted to lobbying efforts to improve schools and teachers' salaries would notnecessarily be wasteful. Resources used in this way will appear to be wasted,however, if the real world is compared with an ideal polity where no informa-tion or transactions costs are required to initiate or maintain the appropriatefunctions of the state. Labeling the resource cost required to maintain legitimatepolitical activity as rent-seeking waste ignores the problem of the "ideal bench-mark" in evaluating government activities, and is another example of the nir-vana approach where the real is compared with an unobtainable ideal.

A real world market will always appear inefficient when measured againstthe norm of perfect competition, and a real world political institution willalways appear inefficient when compared to an idealized polity. The problemof identifying actual examples of "political failure" is similar to that of isolatingexamples of "market failure" in the sense that no one has discovered an ap-propriate benchmark against which to compare real world political institutionswhen information problems, transactions costs, and uncertainty are taken intoaccount. In the absence of such a benchmark, there is no legitimate way tomeasure the efficiency of activities in the real world political process. It canbe said, however, that to the extent that any particular activity is an appropriatefunction of government, it is not legitimate to consider all resources associatedwith securing and maintaining that activity as wasteful rent seeking.

In reality, there is no objective procedure for distinguishing productive fromwasteful activities.16 Consider several widely cited reasons for government in-tervention. The public goods model is taken by many economists to justify awide range of activities including public education, income redistribution,publicly subsidized research, and national defense. Externality theory is usedto justify a host of government programs, agencies, and activities includingthe Environmental Protection Agency, the Occupational Safety and Health Ad-ministration, the United States Department of Agriculture, SCS and land-usezoning. Monopoly theory is used to rationalize various antitrust policies. Manyother restrictions on competition are justified on the basis of consumer ig-norance. There is widespread disagreement, however, both as to when thesemarket failure factors justify government intervention and as to which activitiesare legitimate functions of the state.17 Nor is there agreement as to a bench-mark against which to evaluate the efficiency of government activities in thoseareas where government intervention is deemed to be desirable.18 Consequently,in the absence of a consensus on these issues, there is no objective basis for iden-tifying which lobbying efforts are wasteful and which are beneficial.

Consider agricultural policy and the farm problem. The public interestmodel holds that the purpose of federal agricultural programs is to providea remedy for chronic price and income instability in agriculture. Althoughagricultural price support programs are frequently attacked in the press andby many economists as prime examples of wasteful government activity, many


agricultural economists justify these programs on market failure grounds.19

For example, a recent analysis of the milk price support program concluded:"The relatively small implied consumer-to-producer transfers of the late 1970'sresulting from classified pricing may be a small price to pay for the stabilizingaspect of classified pricing" (Song and Hallberg, 1982, p. 7).

Agricultural marketing orders are frequently justified on similar grounds.Marketing orders for fruits, vegetables, and specialty crops were provided toagricultural producers ostensibly as a tool for achieving "orderly marketing"conditions under the Federal Marketing Agreement Act of 1937. Oranges andother crops marketed under federal marketing orders are subject to quantityand/or quality controls reducing the amounts available for sale. Despite thefact that marketing orders from their inception were intended as means of in-creasing producer incomes (French, 1982), economists continue to attempt tojustify this type of restriction on competition on the basis of economic efficiency.

These regulations are designed to compensate for, or overcome certaincharacteristics of agricultural markets—imbalances in marketing power, in-stability, incomplete information, and the external effects of individual firms'actions—that prevent free trading from being fully efficient (U.S. Departmentof Agriculture, 1981, p. 81).

Opinions of economists and the public at large vary widely as to whether in-complete information, imbalances in market power, price instability, and othermarket imperfections provide a legitimate basis for government price supportprograms in agriculture. What are the implications for the theory of rent seek-ing? If an orange-marketing order, for example, is considered to be a legitimatefunction of government, lobbying efforts to maintain the marketing order wouldnot necessarily be rent-seeking waste. If, however, it is held that restrictionson competition of this type are not justified, the activity of obtaining or main-taining the marketing order would be considered rent-seeking waste.

The situation is similar in the case of labor cartels. Richard Freeman andJames Medoff (1979) contend that the cartel view of labor unions as rent-seeking organizations is seriously misleading. While accepting the idea thatone goal of unions is to raise wages, they argue that by providing workers witha "voice" in the workplace as well as in the political arena, "unions can anddo affect positively the functioning of the economic and social systems" (p.70). If one agrees with Freeman and Medoff that the positive effects of unionsare often more important than their negative effects, the lobbying effortsassociated with obtaining and maintaining such unions would not necessarilybe considered rent-seeking waste. If, however, the net effect of unions is deemedto be negative, resources devoted to unionizing activities would be consideredwaste.

A similar problem arises in the evaluation of lobbying activities to eliminateexisting restrictions on competition. Consider the examples of interest rate ceilings


and price controls on natural gas. If the restrictions are considered to be harmfuldistortions of the market process, lobbying efforts to eliminate them cannotlegitimately be considered as waste.

A difference of opinion concerning the desirability of government interven-tion is evident in many areas including education and research subsidies, oc-cupational licensing, and environmental and safety regulations. Are those pro-grams merely due to imperfections in the political process that often favor thefew at the expense of the many? Or, are there bona fide market failure reasonsfor such programs?20 In the absence of a benchmark against which to measurethe performance of the real world political process, there is no objective pro-cedure for determining when government intervention is warranted or for judg-ing the efficiency of government activities.21 In all of the examples discussedhere, an activity is beneficial or harmful depending upon the observer's values.

In reality, then, there is no objective procedure either in determining whichactivities of the state are illegitimate, or in determining the extent of rent-seekingwaste associated with activities considered to be legitimate.22 While economictheory is useful in explaining activities of individuals and groups in using thestate to further their own ends, it does not provide an objective procedure fordetermining inefficiency or rent-seeking waste. Since utility and cost are subjec-tive, they cannot be measured and aggregated by outside observers to determinesocial cost or utility. Consequently, on strictly economic grounds, the economistcannot reject (or advocate) any public policy (Rothbard, 1982, p. 212). Economictheory, in this sense, is not a substitute for ethical or philosophical analysis.

Decentralized markets are a necessary condition in maintaining individualfreedom. The market, based on free exchange, is the only voluntary methodof allocating resources. Yet, even if one agrees that the central issue is freedomand that reliance on market signals where feasible is ethically superior to knownalternatives, the question just alluded to is still present, namely, what is theproper role of the state in a market economy? There are almost as many answersto the question as there are economists, philosophers, political scientists, andother analysts studying the problem. Consider Albert J. Nock's attempt todiscriminate between productive and unproductive activities.

Nock suggests that man attempts to increase his welfare through twoapproaches—the economic and the political. The economic means is definedto involve the production and exchange of wealth whereas the political meansinvolves the uncompensated appropriation of wealth produced by others (Nock,1973, p. 26). The Nock approach to isolating wasteful activities is operational,however, only if one accepts Rothbard's conclusion that "no act of the Statecan ever increase social utility" (1982, p. 13). In this case, there is an unam-biguous standard by which to identify rent-seeking activity. All activities byindividuals and groups designed to achieve involuntary wealth transfers (pro-grams financed by taxes, price increases through quotas, and so on) would,by definition, be labeled rent-seeking waste.


The Nock approach does not appear to be of much help, however, in thetask of defining the scope of the "limited-government" market economy. Con-sider the example of lobbying by lawyers or police for increased appropria-tions for law and order. If successful, these activities clearly result in an un-compensated appropriation of wealth produced by others. If, however, law andorder are legitimate functions of the state, expenditures to improve these ser-vices are not necessarily wasted. Moreover, the efficiency of production of law,order, and other services deemed appropriate by the state is not susceptibleto measurement. In the words of Knight, "The question whether any type ofpolitical machinery will work 'better' or 'worse' than another is . . . a matterof opinion" (1935, p. 311). And, since opinions vary widely, the identifica-tion of rent-seeking activities is inevitably based on value judgments (often con-cealed ones).

The analysis of this article suggests that neither the appropriate role ofgovernment nor rent-seeking waste can be identified through the cost-benefitapproach. If one accepts the limited state as the norm, there is at least a partialbasis for identifying rent-seeking activities. Efforts by the steel industry to limitimports, for example, would be rent-seeking waste in the eyes of one convincedof the merits of free trade. There remains the normative problem, however,of specifying the appropriate functions of government or, alternatively, of deter-mining how limited the role of the state should be.

Rent Seeking—Measurement versus Existenceand Implications

The fact that wasteful government activity cannot be objectively determineddoes not suggest that the problem of rent seeking is unimportant. Stated dif-ferently, the fact that economists cannot identify or measure inefficiency ineconomic or political markets implies neither the absence of rent-seeking wastenor that political markets are efficient in the sense that there is no scope forimprovement.23 In the remainder of this article, it is assumed that use of thepower of the state to achieve wealth transfers is an increasingly serious problem.Applying an insight from Kirzner's entrepreneurial analysis, there are oppor-tunities to improve the operation of political markets because political decisions(like those of market participants) are never fully coordinated. The followinganalysis describes the effects of widespread rent seeking, problems in reducingredistributive activities, and reasons why a constitutional change may be re-quired to reduce transfer activity.

There is evidence that the "special interest state" in which various segmentsof society organize, each seeking to get its share of government largesse, hasincresed markedly in recent years.24 In achieving their objectives, groups usetheir lobbying power to influence government policy bringing about an increase


in the complexity and scope of government.25 Olson (1982) argues that theeffect of the increase in specialized pressure groups is to gradually strangle theeconomy.26 Moreover, as special interest groups become more important anddistributional issues more significant, political life tends to be more divisive.

Olson's argument concerning the harmful effects of transfers achievedthrough organized group activity is similar to that of F.A. Hayek. Hayek(1979) argues that the chief threat to the market order comes not from theselfish actions of individuals but rather from the selfishness of organized groupswho "have gained their power largely through the assistance government hasgiven them to suppress those manifestations of individual selfishness whichwould have kept their action in check" (p. 85).27 While individual selfishnesswill in most instances lead the individual to act in a manner conducive to thepreservation of the spontaneous order of society, the desire of individuals tobecome a closed group "will always be in opposition to the true common in-terest of the members of a Great Society" (Hayek, 1979, p. 90). The interestof organized groups is typically either to prevent entry of others wishing toshare the profits or to avoid being driven out of production by lower-cost pro-ducers. Hayek suggests that more injustice is done in the name of group loy-alty than from selfish individual motives and he emphasizes the implicationsof redistributive behavior on the political system.

So long as it is legitimate for government to use force to effect a redistributionof material benefits . . . there can be no curb on the rapacious instincts ofall groups who want more for themselves. Once politics becomes a tug-of-war for shares of the income pie, decent government is impossible (p. 150).

Thus, it might be argued that an "economic education revolution" is anecessary precondition for achieving a consensus concerning the need to limitthe role of government and for devising institutional arrangements that canmake these limits stick (Dorn, 1982). This approach implies that a shift inthe focus of economic analysis is warranted—a shift toward political economyemphasizing the framework of institutions and rules within which people caneffectively cooperate in pursuing their own diverse ends through decentralizedcoordination of their activities (Yeager, 1976).

Even if most people recognize the desirability of limiting government ac-tivity, however, there is a "you-first" problem in reducing transfers (Andersonand Hill, 1980). Each recipient of government aid has an economic incentiveto favor a reduction in the transfers received by other people while maintain-ing his own. Thus, it might be argued that the need for an education revolu-tion in ethics is no less important than in economics.28 If individual freedomis accepted as an ethical standard, individuals have the right to engage in mutu-ally beneficial exchange. Moreover, income redistribution through the aegisof the state inevitably involves coercive restrictions on free exchange and in-fringements on individual freedom. Thus, if people were convinced that it is


ethically wrong to achieve wealth increases through political means, the costof engaging in rent-seeking activities would increase with a consequent decreasein these activities. However, as discussed, the case for reducing redistributiveactivities has also been made on nonethical grounds. In the words of Mitchell(1983):

Rational individual and group action will increase transaction costs, producea smaller social product, and in the end leave most worse off. This is thedisastrous dynamic of our democracy. . . . We face the dilemma of individualand collective rationality that general ruin can be the outcome of rational ac-tion (pp. 365-66).

Whether or not the problem of rent-seeking is viewed as an ethical issue,it is likely that a significant reduction in the bargaining society will requireconstitutional reform.29 Buchanan (1977) suggests that the cost of the presentsystem may become so great that the individual transfer recipient will agreeto a change in an existing rule that imposes limited damages on him in ex-change for a reciprocal agreement by others for another set of changes thatwill greatly benefit him. An analysis of alternative methods of limiting the harm-ful effects of special interest groups through constitutional reform is beyondthe purview of this analysis. Possibilities include limits on taxation and spend-ing, reverse revenue sharing, and Hayek's proposal to entrust the general rulesof just conduct to a representative body distinct from the body entrusted withthe task of government (Hayek, 1979; Lee, 1983).

Conclusions

Rent-seeking waste is a matter of opinion depending on one's view of the ap-propriate role of the state, which must ultimately be determined on the basisof ethics rather than economic theory. If emphasis is placed on the freedomof individual choice, there are genuine opportunities for improvements in thepolitical system and strong reasons to reduce the current level of redistributiveactivity. Rent-seeking activities by organized groups are important in the growthof the bargaining society or transfer society with its stifling effect on the com-petitive market process and concomitant shrinking of liberty of choice. More-over, while there can be little doubt that there has been a pronounced increasein the number of groups organized for redistributive purposes, group activitiesgenerally pose little reason for concern in the absence of government assistance.Thus, limiting the role of the state is essential in minimizing the effects of rent-seeking activity.30 There is mounting evidence that a revision of the constitu-tional contract will be necessary to reduce the role of the state. Regardless ofthe approach taken in reducing the scope of government, however, a necessaryfirst step is increased awareness of the economic and ethical implications ofredistributive activities by individuals and groups.


Notes

1. While rent seeking is usually used to describe the effects of groups attempt-ing to obtain wealth transfers through the aegis of the state, the term is also applied(as will be shown here) to the effects of "monopoly" not rooted in government power.In contrast to the orthodox analysis which implies that rent seeking generates socialwaste only in settings where artificial scarcities are created, Buchanan (1983) suggestsin a recent paper that rent seeking emerges in any uncompensated transfer of value—notably with respect to gifts or bequests among persons.

2. This article mainly focuses on problems in identifying rent-seeking activities.Relatively little attention is devoted to the reasons why measurement of waste, evenin principle, is not possible.

3. In the conventional approach, following a specific market event or act ofgovernment to increase or decrease competition, it is assumed that gains and lossesto producers and consumers can be empirically compared. It is argued that this ap-proach is not valid in a later section of this article.

4. Says Worcester (1982, p. 87):

A longer run view of what may seem to be excessive profits or losses is appropriate becauseevery successful penetration . . . because of artful foresight, scientific estimation, or planluck—gives the entrepreneur an edge . . . that can be classified as a monopoly return.There would be no such return if buyers did not find the new superior to the old, andthus, in the large sense, the consequence of a more efficient use of resources.

5. Economic rent is defined in conventional neoclassical theory as the return inexcess of opportunity cost. Since opportunity cost is subjective and profits are createdthrough entrepreneurial activity, there is no way for an outside observer to objectivelyidentify economic rent which, in practice, is taken to mean "excessive profits" or "un-earned returns." As in the case of the distinction between profits and profiteering, theidentification of economic rent depends on judgments of value (von Mises, 1974, p. 129).

6. According to Cowling and Mueller (1980, p. 134):

Gordon Tullock and Richard Posner have argued that previous studies understate thesocial costs of monopoly by failing to recognize the costs involved in attempts to gainand retain monopoly power. These costs could take the form of investment in excessproduction capacity, excessive accumulation of advertising goodwill stocks, and ex-cessive product differentiation through research and development.

[A]nd anyone can try to form a cartel with his competitors or, if he is a member ofa cartelized industry, to engross a greater share of the monopoly profits of the industry."(Posner, 1975, p. 809).

7. The use of the concept of rent seeking for the remainder of this article isrestricted to activities of this type where groups attempt to obtain wealth transfersthrough the aegis of the state.

8. Buchanan and di Pierro (1980, p. 699) write:

There exists basic uncertainty . . . about the set of possibilities that might be realizedupon choice or consequent to choice. In a very real sense, the entrepreneur creates hisown opportunity set and the act of choice enters a new world that unfolds with choiceitself. When this point is recognized, formal theories of probability have little or nocontribution to make to our understanding of entrepreneurial choice.

Wages, Prices, and Employment • 139

9. "In short, when the entrepreneurial aspect of efficient allocation is taken intoaccount, the system will always be in temporary disequilibrium when equilibrium isdefined by static or stationary criteria" (Worcester, 1982, p. 87).

10. In efficiency measurements, welfare economists have generally finessed thisinformation problem by implicitly assuming omniscience on the part of the observingeconomist (Buchanan, 1959).

11. Bhagwati (1982) proposes "directly unproductive, profit-seeking" activitiesas a general concept that includes conventional rent seeking as a special case.

12.

How, then, do we tell a government action that we shall call redistributive . . . ? Essen-tially, we must look at the motives of the act. . . . When we observe a governmentthat does not seem to be solely aimed at improving the efficiency of the economy, defend-ing the country, suppressing murder, etc., we call it redistributive (Tullock, 1983, p. 13).

13. A dramatic example of the positivist approach appears in Tullock (1983, p. 7):

Let us, for example, take a fairly clear-cut case in which income generates rather littleutility: people who are seriously and permanently crippled, such as multiple sclerosisvictims. It is fairly obvious that the marginal utility derived from each dollar put inthe support of such people is low. If we were attempting to maximize total utility, wewould surely cut back on our expenditures to them and increase our expenditures tothe beach boys of Malibu.

14. Stigler (1982b) holds that although economic analyses of government interven-tion including minimum wages, rent controls, and so forth are "tolerably accurate"as to their effects, economists' policy advice on these issues is disregarded becauseeconomists are uninformed concerning political desires of the community: "The trueaccount, then, is that the economists refused to listen to the society, not that the soci-ety refused to listen to economists. What the economists had to say that was relevantwas heard and acted upon" (pp. 15-16). In this view, economics teaches the worth-lessness of public policy advice. Studies by public choice economists, by the neoclassicistsof the Chicago school, and by the Austrians, however, have helped to make the casefor limited government and free markets (McKenzie, 1983, p. 53).

15. Says Buchanan (1959, pp. 137-38):

The individual preference patterns which he incorporates into his models must be con-ceived as presumed or predicted, and the changes which are based on these must alwaysbe considered tentative hypotheses to be subject to testing in the polling places. Theeconomist can never say that one social situation is more "efficient" than another.

16. Self-interest is likely to play a role in people's attitude toward particulartransfers. In the words of Stigler (1982b, p. 15), "One is entitled to suspect that a per-son's disapproval is related to his circumstances: economists believe that federal sup-port of their research is more desirable than federal support of industrial research."

17. For example, occupational licensing of real estate salespeople, medical doc-tors, and the like means that the licensed businesses are not as competitive as they other-wise would be (Tullock, 1980a, p. 17). Yet many (most?) people appear willing topay a higher price in exchange for a perceived increase in information and decreasein uncertainty associated with such restrictions on competition.

18. Browning (1974) points out that rent-seeking behavior may be important inproviding information to legislators, which further complicates the benchmark prob-lem in identifying rent-seeking waste.


19. Gardner (1981) discusses the theory that agriculture has specialcharacteristics that unregulated markets cannot properly handle.

20. Ruttan (1980, p. 531) argues, for example, that there is currentlyunderinvestment in publicly supported agricultural research.

The observed annual rates of return typically fall in the 30-60 percent range. . . . It ishard to imagine very many investments in either private or public sector activity that wouldproduce more favorable rates of return. There is little doubt that a level of expenditurethat would push rates of returns to below 20 percent would be in the public interest.

If Ruttan's conclusion were correct, the lobbying necessary to bring about this resultcould not legitimately be considered rent-seeking waste.

21 . Worcester (1982) discusses the "forbidding task" of developing an economicmodel that can properly be used as a basis for policy making. He concludes: "Economicanalysis suitable for policy must provide a negative answer to the first and a positiveanswer to the second of these questions:a. Is any unavoidable task ignored or excluded by assumption?b. Has an equally skeptical investigation been made of the viable alternatives?" (p. 87).

22. Rothbard (1982) explains why utilitarian approaches cannot be used to makethe case for or against particular restrictions on competition.

23. There is a subtle difference between the existence and the measurement of in-efficiency (or errors) by decision makers. The outside observer cannot detect error orisolate inefficiency on the part of decision makers since utilities and costs are subjec-tive. The individual may err, however, in the sense of acting in a way so that he or sheis placed on a position viewed "as less desirable than an equally available state" (Kirz-ner, 1979, p. 120). Moreover, as Mitchell (1983) suggests, individuals and groups mayknowingly be induced by short-run considerations to engage in activities which, if widelyadopted, can lead to general ruin.

24. "(TJransfer activity, originally quite limited, has come to play a much moresignificant role in the lives of all Americans" (Anderson and Hill, 1980, p. 91). Johansen(1979) refers to the proliferation of groups being organized with the aim of negotiatingwith the state to improve their economic condition as "the bargaining society."

25. Says Olson (1982, p. 69):

Lobbying increases the complexity of regulation and the scope of government by creatingspecial provisions and exceptions. A lobby that wins a tax deduction for income of acertain source or type makes the tax code longer and more complicated; a lobby thatgets a tariff increase for the producers of a particular commodity makes trade regula-tion more complex than it would be with no tariff at all.

26. Olson is ambivalent about the effects of conventionally defined monopolypower. Monopoly gains are said to arise because output is reduced to obtain a higherprice (p. 45). He argues, however, that though supranormal profits are common, theirsource is innovation.

But what gives rise to these temporary profits? Most notably, innovation of one kindor another. . . . And the greater the extent of the profits due to difficulties of entry andimitation, the greater the reward to the innovations that mainly explain economic growthand progress (Olson, 1982, p. 61).

27. Although Olson (1982) stresses the harmful effects of special interest groups,he fails to recognize the importance of the state in creating and maintaining such groups.


Indeed, he holds that "there often will not be competitive markets even if the govern-ment does not intervene. . . . There will be cartelization of many markets even if thegovernment does not help" (Olson, 1982, pp. 177-78).

28. I am indebted to Robert Batemarco for this insight.29. Yandle (1982) traces the roots of government to rent-seeking behavior. Govern-

ment emerges as a producer and monitor of property rights because of common accessproblems. A useful way of analyzing the conditions giving rise to decay in the legislativeprocess is to view public officials as rent seekers in the legislative commons.

With representative government the legislative arena is the commons upon which pro-perty rights are formed. The legislators are the sheperds and the laws passed by themare the grazing. The constitution is the monitoring device. If the basic contract—theconstitution—fails to monitor the commons, overgrazing occurs. (Yandle, 1982, p. 324).

30. "While collective choice stands in the sharpest contrast to the market, marginalimprovements are possible. But of all improvements the most effective is a steady diminu-tion of the scope of government" (Mitchell, 1983, pp. 367-68).

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